After extensive review and public hearings, the SEC issued a 165-page report that called for significant steps to place under greater scrutiny a massive, loosely regulated portion of the financial markets, one that still attracts investment from everyday Americans.

The so-called retail investors fled stocks and bonds in the wake of the 2008 financial crisis, leaving most investing in these instruments to influential pension-fund managers and Wall Street powerhouses that do high-speed computer trades. But ordinary investors still make up the brunt of municipal securities purchases.

“The funds raised through this market help finance roads, schools, hospitals and so much more,” SEC Commissioner Elisse Walter said during a conference call to discuss recommendations in the new report she spearheaded.

The SEC asked Congress to give it the authority to create a standard form and content for financial statements for issuers of municipal securities and to recognize a designated private-sector group as the standard setter. The agency wants new powers to audit the issuers of municipal bonds, and it asked for a new law to allow the IRS to share information with the SEC about tax returns, audits and examinations in cases where there are concerns about securities fraud.

At the start of this year, there were more than a million different municipal bonds outstanding, valued at more than $3.7 trillion, according to the SEC. Retail investors hold about 75 percent of those, the agency said.

There are also more than 44,000 state and local issuers of municipal securities, commonly known as general obligation bonds or revenue bonds. These allow localities to raise money to build roads, bridges, stadiums, schools and other public works projects.

The municipal securities market, however, has been under great scrutiny of late, with some prominent Wall Street analysts warning of potential large-scale defaults by state and local governments in coming years as tax revenues remain weak and deficits large. Regulators reportedly also are looking at potential corruption in the compilation of an index that’s used as a benchmark for municipal bond pricing.

The Municipal Securities Rulemaking Board, an industry self-regulator created by Congress that gets oversight from the SEC, confirmed this week that it’s studying how the benchmark index is set. The board acknowledges that there’s little transparency in the process, and the issue takes on new importance after the so-called Libor scandal, in which British bank Barclays recently acknowledged that it had been manipulating the setting of an interest rate that’s used in U.S. car, student and home loans.

Under the SEC’s proposals, the board or some new private entity would set standards that would apply for issuers of municipal bonds. Historically, the SEC’s involvement in this market has been from the angle of investor protection, but it’s lacked the oversight powers it enjoys with stocks and bonds. State governments regulate the issuance of municipal bonds, and some industry critics suggest that amounts to having the fox guard the henhouse.

Asked whether the proposals intrude on turf guarded jealously by state regulators, SEC Commissioner Walter said the agency didn’t recommend significant changes to what now fell to states and what to the federal government.

“There would be no state pre-emption. We think it’s a nice mesh,” said Walter, noting that the goal is to protect investors across the nation. “Like any investment, there is risk involved, and there is risk of default. But the issue here is to look at the regulatory system and see if there are holes.”

The SEC plan may get a cold shoulder from Republicans, who’ve made the costs of increased financial regulation a campaign theme. Still, the chairman of the House Financial Services Committee, Rep. Spencer Bachus, R-Ala., welcomed the report.

"This report is timely as there is an increasingly challenging environment facing municipalities because of the economy. Increased disclosures could go a long way to help protect investors, taxpayers and ratepayers," he said in an email to McClatchy. "I look forward to discussing the report’s recommendations with the SEC and other municipal market participants at a hearing this fall.”

The North American Securities Administrators Association, the trade group for state regulators, didn’t return calls requesting comment. It’s supported greater transparency in disclosure statements to investors, but it may not want to cede powers to the federal government.

The main trade group for Wall Street firms, the Securities Industry and Financial Markets Association, offered lukewarm support. In an interview, the co-head of the group’s municipal securities division said that greater and more timely disclosure was needed, but she cautioned that the SEC doesn’t need new congressionally granted powers.

“We feel significant changes can be made without going through the (legislative) process,” said Leslie Norwood, adding that the group doesn’t support creation of a national body that sets “one size fits all” standards for issuers of municipal bonds.

Norwood added that “some states have their own laws on audit and accounting requirements” and “the historical default rate in municipal securities has been very low.”

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